To Deter or to Moderate? Alliance Formation in Contests with Incomplete Information

Max Planck Institute for Tax Law and Public Finance; Social Science Research Center Berlin (WZB); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); IZA Institute of Labor Economics

Goethe University Frankfurt; Max Planck Institute for Tax Law and Public Finance

Date Written: December 22, 2015

Abstract

We consider two players' choice about the formation of an alliance ahead of conflict in a framework with incomplete information about the strength of co-players. When deciding on alliance formation, players anticipate the self-selection of other players and the informational value of own and other players' choices. In the absence of these signaling effects, strong players have an incentive to stand alone, which leads to a separating equilibrium. This separating equilibrium can be destabilized by deception incentives if beliefs are updated on the basis of endogenous alliance formation choices. Weak players may find it attractive to appear strong in order to deter competitors from positive effort choices. Strong players may find it attractive to appear weak in order to give their competitors a false sense of security and then beat them with little effort. Moreover, appearing weak allows players to free-ride when alliances are formed.

Konrad, Kai A. and Morath, Florian, To Deter or to Moderate? Alliance Formation in Contests with Incomplete Information (December 22, 2015). Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2015-15. Available at SSRN: https://ssrn.com/abstract=2707054